Sunday, December 12, 2010

Hamilton evaluates QE2 (amv)

Very important facts to notice:

1) Is QE2 optimally designed to flatten the yield curve?
What you see: "Comparison of effects of purchases targeting different maturities. Horizontal axis: maturity (in weeks). Vertical axis: change in yield for that maturity (in annual percentage points) resulting from proposed change. Red dashed curve: effects of $400 B purchase of securities of 10-year maturity and longer (identical to dashed line in Figure 11 in Hamilton and Wu). Blue solid curve: effects of $400 B purchase of maturities between 2-1/2 and 10 years. Both curves assume the policy is implemented when investors believe that the overnight rate is likely to remain stuck at the zero lower bound for an extended period and that there are no offsetting changes in securities resulting from new Treasury issues."

2) Does fiscal policy support the change of maturity composition intended by the Fed?
What you see: "The blue line is the average maturity (in weeks) of debt issued by the U.S. Treasury. The green line is the average maturity of publicly held debt, that is, the green line represents the results of subtracting off the Fed's holdings of Treasury debt. Historically the green line was above the blue. This is because the Fed preferred to buy the shorter-term debt, as a result of which the average maturity of the remaining debt held by the public (green) was bigger than that for the debt as originally issued (blue). However, since the start of 2008, that relation has been reversed-- the Fed has been buying a disproportionate share of the longer-maturity debt, and thus has been a factor in reducing the average maturity. [...] But note that, despite the fact that the Fed is buying more long-term debt, the average maturity of publicly held debt has still been increasing sharply since 2009. Over the last year and a half, the Treasury has been issuing new long-term debt much faster than the Fed has been buying it."

and: "[...] So if the Treasury were to continue to issue debt in the amounts and proportions that it has been over the last year, the Fed would only end up absorbing the new debt in this category over the next 6 months, while the amount that is less than 2-1/2 years or greater than 10 years would continue to grow."

thus: "In other words, given the modest size, pace, and focus of QE2, and given the size and pace at which the Treasury has been issuing long-term debt, the announced QE2 would have been associated with a move in the maturity structure of the opposite direction from that analyzed in our original research. The effects of the combined actions by the Treasury and the Fed would be to increase rather than decrease long-term interest rates."

The conclusion his however surprising.